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What Cisco earnings don't say that tech buyers should know

While the latest Cisco earnings show the vendor has solid demand for its networking gear today, tech buyers shouldn't ignore the obstacles Cisco is likely to face in the future.

Cisco's latest earnings report demonstrates the vendor knows what companies want in networking today. What it doesn't show is whether Cisco can align its business to the challenges it will face in the future.

Last week the company reported results for the fiscal quarter, which ended Jan. 24, that indicated a comeback from a year ago when revenue and profit each fell 8%. This time around, sales rose 7% year over year to $11.9 billion, while net income grew 68% to $2.4 billion.

What tech buyers need to know

The results are important to corporate tech buyers in the market for networking gear because they indicate that Cisco is selling legacy technology and is carving a niche for its variant of software-defined networking (SDN), which is the trend toward using more flexible software to control network functions instead of specialized switching gear.

If you look at sales and account management, it still smells like a hardware company.
Peter Christyanalyst 451 Research

The heart of Cisco's networking software is its Application Centric Infrastructure (ACI). Deploying an ACI-anchored network became possible last July when Cisco released the Application Policy Infrastructure Controller (APIC), which manages the physical components within an ACI deployment. Since then, Cisco has sold 300 APICs, according to the company.

Cisco's approach to SDN is to tie the software to its hardware, the opposite strategy to VMware, which builds its NSX rival to run on any hardware. Cisco's strategy paid off last quarter by driving switching revenue up 11% to $3.6 billion.

Revenue from the Nexus 9000 line of switches, which run the company's latest software, grew 350%, the company reported. More than 1,700 organizations have bought the Nexus 9000, up from 970 in the first fiscal quarter.

The Cisco advantage

Why Cisco has managed to keep customers, rather than lose them to upstarts providing only software-based networking, comes down to trust, experts said. Most companies are unwilling to try new technology from a vendor they have not worked with in the past.

A maker of car parts, for example, wants a network that's dependable so it can focus on those parts of its business that differentiate it from competitors.

"Networking is business-critical, but never differentiated," said Peter Christy, analyst for 451 Research. "For most businesses, all they want is a network that operates reliably."

Cisco is gaining traction in the market by combining hardware and software, not just in networking, but also in data center technology. More than 41,000 organizations use the company's Unified Computing System (UCS), which combines computing, networking and storage. Overall, Cisco's data center business rose 40% against competition from Hewlett-Packard and Dell.

Cisco's future hurdles

Despite its success today, Cisco will face increasing pressure to separate software from hardware as the SDN market matures and grows, IDC analyst Rohit Mehra said. By 2018, IDC predicts the global SDN market will grow to $8.2 billion from $960 million last year.

Cisco recognizes the trend and has said it plans to double software revenue to $12 billion by 2018. However, Cisco clearly has a ways to go before industry observers see it as a software company.

"If you look at sales and account management, it still smells like a hardware company," Christy said.

Another potential problem is the trend among large Internet companies and cloud providers like Amazon, Facebook and Google to custom design their own switches and networking gear on open standards.

The Chinese and Taiwanese computer makers hired to build the technology could one day sell the equipment. Cisco will likely compete with these manufacturers in the future to avoid missing out on the high-end, cloud provider market, Mehra said. For now, Cisco's strategy against the emerging competition is a "work in progress."

"I do think that market will be a tough environment for Cisco to crack," Mehra said.

Cisco will also need to solidify its strategy for IoT, which the company calls the Internet of Everything (IoE). Despite promoting the future value of the IoT to the industry, "providing financial metrics and guidance will be a challenge due to the nature of defining which technology was exclusively purchased and used for an IoE/IoT ecosystem," IDC said in a recent research note.

For now, Cisco's product breadth, which is larger than any other company in networking, is likely to keep the vendor on most companies' short list, experts said.

"What Cisco has is really interesting, and, at the moment, is clearly differentiated from their competitors," Christy said.

Next Steps

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How do you think the SDN market will progress over time?
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The same way every other market in electronics develops - either it grows so useful and integral that people no longer do things without it or they move on to a better setup. It's hard to say which of these is more likely at the moment - though I always lean towards things getting replaced over time unless they're as fundamental as the wheel - but I am expecting to see billions in growth in a few years.
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I'm going to hold off on making predictions for the SDN market. In my opinion, the jury is out on how mainstream enterprises will adopt the technology.
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Cisco can still stay a hardware company by creating equipment to connect all of the IOT devices about to come into organizations.
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Long term, I don't believe Cisco can remain a hardware company. Chambers has acknowledged that, saying the company plans to spend a lot on developing software. That said, it's all about giving customers what they want. Companies like the idea of network control moving to software, so Cisco is going to have to take what it has today and push it much further.
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As a former Ciscoite, it seems Cisco has come full circle. Back in the early 90s, Cisco Systems was a software company that happened to have hardware. With a relentless acquisition appetite, they either bought, integrated or branched into lots of hardware offerings, but at the end of the day, it's the software and the ability therein that made the difference for Cisco. The alumni in me wants to see Cisco succeed, but they need to remember what differentiated them in the first place (i.e. the code).
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I agree. Whether it's Cisco or a rival, the competitive advantage in the future will come from software.
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